May 22, 2020 Quarterly Newsletter Q1 2020
Posted By FAS
A Quarter to Forget
Let us start by saying we hope this finds you well and that everyone is staying healthy.
First quarter of 2020 was one to remember – or forget, depending how you look at it. The Dow Jones experienced the worst quarterly decline since 1987, falling -23.2%. The S&P 500, down an even -20% in Q1, posted its worst quarterly decline since 2008. The NASDAQ ended the quarter down -14.18%. Small caps fared worse than most major indices ending Q1 down more than
-30%. International markets fell in tandem with domestic markets. The MSCI EAFE was down -23.43%. The only safe haven aside from cash and gold was fixed income, which returned a positive 3.15% as the 10-year Treasury rate fell from 1.92% down to 0.70%.
Q1 started out similar to most quarters we have seen in recent past with all major U.S. indices reaching record highs on several occasions. The running themes we had mentioned in previous updates – trade tensions, an overly aggressive Fed, and fear of peaking earnings – still appeared to be at the forefront of concerns, albeit slightly subsiding. The U.S. and China trade war made progress in the right direction with the signing of the “Phase One” trade deal in mid-January. The Fed entered the year having recently cut interest rates, indicating a tamer tone moving forward. Moreover, the markets had seemed to accept the potential for low single-digit earnings growth as markets continued to rise to lofty valuations on the positive news of fading geopolitical tensions from early January. The Dow reached an all-time high on Feb 12 and the S&P and NASDAQ followed hitting their record highs on Feb 19.
Beginning late February and continuing throughout March equity markets dropped sharply as new cases of COVID-19 Coronavirus surged around the world. This was the primary, but not the only, reason for the recent declines. There are now over 1M cases of COVID-19 worldwide, over 800,000 of which are still “active cases.” In the United States, there are over 245,000 cases.
Markets have been aware of COVID-19 since late 2019, however throughout January and most of February it was not a material, negative influence on U.S. equities or credit markets due to nearly all active cases being in China. It was assumed the virus would be mostly contained given the draconian quarantine measures the country had taken. That assumption proved false,
and beginning around February 19 the number of active cases began to accelerate dramatically in South Korea, Iran, and Italy. The swift spike in new COVID-19 cases outside of China resulted in a sharp drop in stocks in late February.
Those declines compounded in early March as the number of active COVID-19 cases in the U.S. began to increase at a rapid pace. The S&P 500 tumbled more than 10% amid rising fears the epidemic was quickly evolving into a global pandemic.
On March 9 U.S. markets and the economy were dealt another surprise blow when Saudi Arabia effectively abandoned OPEC-mandated production levels and began to dramatically discount oil prices and increase oil production. The move was in direct response to Russia refusing to comply with proposed “OPEC+” production cuts at which point an oil price war broke out between
the two countries causing oil futures collapse nearly 25% in a single day.
Historically, lower oil prices would translate to lower gasoline prices – a net positive for U.S. consumers. However, thanks to the recent shale revolution, the U.S. is now not only the largest oil producer in the world but also the largest net exporter of refined oil. The U.S. energy industry is valued at more than $340B. With oil prices falling so low and shale being significantly more
costly than traditional drilling, it puts many U.S. energy companies in a position that may ultimately force them to halt production, cut costs, and reduce payroll, further exacerbating the blow to both earnings and unemployment.
Stocks fell even further in mid-March in response to extreme social distancing measures implemented by municipalities across the country. The entire country was effectively shut down as travel bans, school closures, and non-essential business closures were put into place in an attempt to slow the spread of the virus. The cumulative impact of these measures materially increase the probability of a recession – officially defined by two consecutive quarters of negative GDP growth. The knock-on effects of social distancing are proving to be a drag on the economy. Consumer spending is the largest contributor to GDP (about 70%) and retail, entertainment, restaurants, transportation, and hotel and leisure – all subsectors of consumer spending – account for 20% of GDP. Likewise, these same industries account for roughly 20% of U.S. jobs. Together these industries account for approximately 7% of S&P 500 earnings, so while we may see less of an impact on corporate earnings compared to the Global Financial Crisis, it could very well have a larger impact on the economy which is why the government reacted so aggressively both on the monetary side and the fiscal side.
With respect to monetary stimulus, the Fed acted quickly and immediately cut the fed funds rate by 1.5% down to 0% in addition to restarting quantitative easing (QE) and bringing back lending programs to provide the banking system with appropriate amounts of capital.
On the fiscal side, congress passed a $2.3T stimulus bill – three times the size of the 2008 relief package –which includes increased and extended unemployment benefits, loans and grants to businesses, and direct payments to taxpayers with the goal of essentially keeping the economy in suspended animation until cases peak and begin to decline. The primary goal is to ensure unemployment does not evolve into poverty and that lost revenues do not lead to bankruptcies.
The disruption to the economy caused by the virus has been unique in the sense it has caused both a supply and a demand shock simultaneously. There is not an oversupply of goods with suppressed demand from a high unemployment rate as much as there is less demand for less products and services being produced. Once cases of the virus peak and decline, social distancing measures will be eased and there should be a lot of pent up demand ready to be released into the economy. Air travel will resume, cruise ships will sail, and the consumer will leave the house and spend, bringing back a large number of jobs lost. Looking at this cycle in three stages, we have experienced a fall, are currently experiencing a stall, and should experience a surge once we are through this.
New FAS Team Member
As we continue to strive to better serve our clients FAS has added a new team member, Isaac Boll. Isaac is a Springfield, MO native who has moved to Kansas City to join FAS as a financial planner. He attended Missouri State University where he acquired a bachelor’s degree in finance and has worked in the financial services industry for five years. Isaac, along with two of FAS’s current team members, Jason Calkins and Anna Barnes, recently passed the CERTIFIED FINANCIAL PLANNER® exam. Please join us in congratulating our three team members and welcoming Isaac to the FAS family.
What makes this downturn different is that we know there is an end date. It may not be for several months until we have a vaccine, but that day will come and once it does, the markets will have most likely already anticipated it and reacted accordingly. The markets have not once, in history, failed to reach their previous highs.
While no one could have foreseen the impact this virus would have on the markets and the economy, events such as this are why we have spent time with you designing a long-term financial plan.
Through this difficult but ultimately temporary disruption that plan is designed to help you achieve your personal, long-term financial goals. Meanwhile, equities in the most robust economy in the world are currently at multi-year lows. Tumultuous episodes such as these can create fantastic investment opportunities and some of the most ideal buying conditions the market can offer.
Past performance is not indicative of future results but history has shown that a long-term approach combined with a well designed and well-executed investment strategy can overcome periods of heightened volatility, market corrections, and even bear markets. Your advisors at FAS are here to guide you through these difficult times and ultimately come out stronger on the other side.